Harry Domash, Online Investing: MLP General Partners' stock soars

A year ago, on Aug. 25, 2013, I described MLP General Partners (GPs), a relatively unknown stock category. Hopefully, you paid attention. As of Aug. 18, the four stocks that I mentioned in the column had averaged a 65 percent total return — dividends plus price appreciation. Now that I have your attention, here's some background.

Natural gas production is growing dramatically. For instance, it has increased 24 percent over the past five years. With supply temporarily exceeding demand, natural gas prices dropped more than 60 percent since peaking in 2006, and almost five percent just since my August 2013 column. The lower prices motivated many users to switch from coal and crude oil to natural gas, which in turn, hiked demand.

Unlike crude oil and gasoline, natural gas can only be transported from the wells to the end users via specialized pipelines. Consequently, soaring natural gas production must be matched by similar growth in natural gas pipeline capacity.

Most natural gas pipelines are owned and operated by Master Limited Partnerships (MLPs). Because they are partnerships, not corporations, MLPs do not pay federal income taxes. Consequently, many pay relatively high dividends, typically equating to five percent to seven percent yields, making them attractive to income investors.

Here's why you should consider buying GPs instead of their MLPs. The general partner usually takes a percentage of its MLP's cash flow, and then distributes the balance to the MLP's limited partners. The GP's percentage typically increases as the MLP's cash flow grows. For instance, the GP's cut might start at two percent, but then ramp up to 50 percent over time.

Here's why that's important. Say that three years ago, an MLP generated cash flow of $200 million and its GP took 10 percent. Thus, the GP collected $20 million, and the limited partners received the balance; $180 million. Now, assume that this year the MLP generates $400 million from its pipeline business, but now the GP takes 25 percent. In this instance, the GP takes $100 million leaving $300 million for the limited partners. So, over the three years, the GP's take grew 400 percent compared to a 67 percent gain for the limited partners.

General partners can be organized as corporations or as MLPs themselves. Stick with corporate GPs. Their tax return requirements are simpler, you can hold them in tax-sheltered accounts such as IRAs, and their dividends are subject to a maximum 15/20 percent federal tax rate. Here are four worth considering: Oneok (OKE), Plains GP Holdings (PAGP), Spectra Energy (SE), Williams (WMB).

These are my ideas. As always, do your own due diligence. The more you know about your stocks, the better your results.